In a stunning announcement the Fed lowered rates by .75% or 75 basis points to an all time low. What is the cause and effect?
First, the cause is relatively simple and can be seen in the capital markets. With much lower values in equity markets, not to mention residential home values, the Fed lowered rates in order to stimulate the economy. In our opinion this is an excellent decision, given the current situation. Looking forward we may revisit this decision, but for now let’s review the here and now.
By lowering rates to almost zero the Fed is going “all-in” to use a poker term (borrowed from Paul McCaulley) in an effort to stimulate the economy. This bold move was a surprise to many as estimates ranged from no change to at most a lowering of .50%. Due to the accelerating decline in all the economic benchmarks almost any statistic we review is showing a decline. The economic declines allowed the Fed to lower rates without the fear of inflation for the short term. The economic decline was fast and began with legitimate underpendings. As time passed investors, employees, and employers became even more pessimistic leading to the old mantra “Perception becomes reality!” The Fed is making moves to break this cycle.
An effect is best seen by reviewing the actual statement, as the wording was as important as the actual decision to lower rates.
“The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.”
Click here to see complete statement: http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm
The part of the statement highlighted above is a clear signal to lower mortgage rates which will allow for a refinancing boom, pending home values appraise high enough for refinancing. From this statement alone, we would expect mortgage rates to begin falling over the coming weeks. If consumers are able to refinance the net effect may be to stabilize home values and begin a rebuilding of confidence in the all important consumer (who accounts for over 70% of GDP). JK